WSJ Survey: Bank of Canada to Raise Rates Wednesday

Bank of Canada watchers are in agreement: The central bank will raise its benchmark interest rate Wednesday because the employment data have been too strong to overlook.

The Bank of Canada's expected move comes even though the uncertain fate of the North American Free Trade Agreement hovers over the economy. To date, trepidation over the possible dissolution of Nafta has yet to show up in the economic indicators, or in the central bank's own survey of firms.

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Economists surveyed from 10 of the 11 primary dealers of Canadian government securities told The Wall Street Journal they anticipated the Bank of Canada to lift its benchmark rate by a quarter-percentage point, to 1.25% from 1%, making it the first Group of Seven central bank to raise interest rates in 2018. The last time the Bank of Canada policy rate was near this high was in early 2009, when it sat at 1.5% before then-governor Mark Carney cut it by a half-percentage point in response to the financial crisis and global recession.

The economists surveyed said employment growth has been exceptional, with the jobless rate falling to a four-decade low of 5.7% and 2017 marking the best year for job creation since 2002. Nearly 200,000 net new jobs were created in the final quarter of 2017, or the most robust rate of quarterly growth since the start of the decade.

Analysts say the recent string of positive employment gains and strength in wage increases have worked to undermine a view from the Bank of Canada Governor Stephen Poloz that slack, or unused capacity, remains in the labor market.

"The bank will find it hard to look through the strength in the data -- from blockbuster job gains, new lows in labor slack, and improvement in core inflation," said Brittany Baumann, strategist at TD Securities.

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Besides job growth, inflation has also perked up, with the annual rate crossing the 2% threshold in November for only the second time in three years. Economic output has slowed markedly after a stellar run, but is still expanding at a 3.4% year-over-year pace as of October.

The central bank raised rates in July and September last year on strong growth. The Bank of Canada then paused in October and said it would be cautious, arguing it wanted to gauge how indebted households responded to higher borrowing costs and get a better grasp on Nafta. Mr. Poloz said it would be guided by incoming data when making decisions.

Nafta talks have turned contentious, with rhetoric escalating between the U.S. and Canada. The next round of negotiations will unfold next week in Montreal, and they are largely being viewed as a make-or-break session. A published report last week indicating President Donald Trump would imminently withdraw from Nafta led to a downturn in the Canadian and Mexican currencies last week, and a decline in shares of auto firms.

The worry over the end of Nafta wasn't evident in the Bank of Canada's most-recent quarterly survey of businesses. An indicator measuring capital-spending plans -- a proxy of trade uncertainty -- rose to close to a post-financial-crisis high, with nearly half of the companies surveyed expecting to fork out more money on machinery and equipment over the next 12 months. Hiring intentions also rose, and firms said labor shortages are "more intense" than a year ago in sectors such as technology, tourism and construction.

"We are cognizant of the risks to Nafta," said Derek Holt, economist at Bank of Nova Scotia, "but [also] accept the argument that this risk could overhang the Canadian economy for months, quarters or years. There is a limit to how long monetary policy can be put on hold as the economy faces accelerating wage and price pressures amid capacity constraints."

Bank of Canada's No. 2 official, Carolyn Wilkins, said in a speech last year that uncertainty about the Trump administration's trade policy would be an "important uncertainty" in the outlook. "But," she added, "life goes on and decisions must be made in the meantime."